Several years ago, I had the memorable experience of listening to Bill Gates defend the structure of the company that he built. It was during the height of Microsoft’s (NSDQ: MSFT) war with the Justice Department. Gates, facing a roomful of skeptics, argued forcefully that breaking up the company made no business sense. But having watched the failure of the company’s $47.5 billion bid for Yahoo (NSDQ: YHOO), it’s hard not to wonder: maybe the government had a point.

Microsoft is struggling to regain the initiative against Google (NSDQ: GOOG). Size is relative, but Google is the smaller and faster moving of the two giants. Google revenue soared 41 percent during the latest quarter, while Microsoft sales were nearly flat. Microsoft’s answer to this dilemma: get even larger. Maybe it would make more sense to wage this battle by slimming down.

A Microsoft breakup might seem shocking, but it would be consistent with a broad movement toward corporate consolidation. More after the jump…

Time Warner (NYSE: TWX) is shedding its cable systems, and Barry Diller’s IAC (NSDQ: IACI) is breaking into five pieces. There were calls in April for the breakup of GE, because the king of all conglomerates had a bad first quarter. And the calls for a breakup of the sprawling Yahoo empire, which go back years, have grown only louder since Microsoft’s withdrawal.

Even after a breakup, Microsoft’s enterprise software business would still be more than large enough to serve its clients. Oracle is just one third the size of Microsoft. SAP is less than one fourth of Microsoft’s size. The big companies that buy Microsoft software don’t really benefit from the fact that Microsoft sells the Xbox. And Zune users aren’t about to download the latest SQL server.

Following the lines of the company’s financial reporting structure, one could break the company into five units: operating systems, servers, business applications, online and entertainment and devices. Some of the pieces could be combined. All the software units have a similar financial profile, with strong cash flow and revenue growth in the mid-teens. And the online and entertainment units have (mostly) solid cash flow, but big operating losses tied to the investment cycle.

Breaking up the company would unlock a lot of value. The company lost $24 billion during the Yahoo episode, and has a current market cap of $272 billion, or $29 a share. Lehman Brothers expects the price to move to $34 over the next year. That’s still well below Lehman’s previous Microsoft target of $39, which implied a market cap of $319 billion. An uncertain online strategy — and the risk of huge deals — is depressing the stock. Nothing short of a breakup is likely to remove that overhang. It’s far better to take action now, than to wait until the shareholder activists are at their door.

Inside The Deals is a weekly column about M&A in the media written by veteran business journalist Steve Rosenbush. Steve is based in New York, and previously was the finance writer for BusinessWeek.com, responsible for coverage of M&A. His interests include the evolving business of media. He can be reached at steve AT paidcontent.org.